Profits Available for Distribution
Section 830 of the Companies Act 2006 provides that a dividend or distribution to shareholders may only be made out of profits available for the purpose, as shown in the ‘relevant accounts’.
Relevant accounts include year-end accounts drawn up according to applicable UK Law and accounting standards, and for private companies interim management accounts which contain sufficient information to support the decision to pay a dividend. Profits available for distribution are defined as accumulated realised profits less accumulated realised losses. Distributions cannot be lawfully made out of capital.
Directors should have regard to whether the company will continue to be solvent after the proposed distribution, considering short-term cash flow implications and continuing ability to pay debts as they fall due.
So how do the directors establish profitability, and critically, demonstrate that they have done so? If distribution can’t be justified from the last statutory accounts, interim accounts will be needed. Private companies must show that the accounts facilitate reasonable judgment with regard to profits, losses, assets and liabilities, provisions, share capital and reserves. A good set of management accounts should provide sufficient evidence, noting that they may require some adjustments, for example to include tax.
Non-compliance will render distribution unlawful (CA 2006, s. 836(4)). Ultra vires and illegal dividends can have unwelcome consequences. If, for instance, a member knows (or has reasonable grounds to believe) that a distribution is unlawful (i.e. it contravenes the 2006 Act), there is a liability to repay. In some circumstances, directors can become personally liable where they authorise an unlawful distribution which cannot be recovered. Note also that HMRC are becoming increasingly aggressive in requiring ultra vires dividends to be repaid by directors of insolvent companies.
Paying in Proportion to Shareholding
Payment is usually made in proportion to shareholding. However, there can be occasions on which this is varied, for example, by means of dividend waiver. Alphabet shares provide flexibility to tailor dividend payments. Again, care is needed to get the detail right.
Shareholders can make a waiver – i.e. opt not to take a dividend when declared: but the right to a dividend must be waived before the dividend is declared. Waiver can be effective for all future dividends, or for any future period of time, or for specific dividends. But note, as stated by HMRC:
‘An act that purports to be a waiver after payment is no more than an assignment or transfer of income, which may constitute a settlement vulnerable to the settlements legislation of ITTOIA 2005, Part 5, Chapter 5.’